A review of moving average crossover indicators

Price Crosses Moving Average
Indicator

Implication

When a security's price crosses its moving average (the event), a bullish or bearish signal is generated depending on the direction of the crossover.

Description

A moving average is an indicator that shows the average value of a security's price over a period of time. This type of Technical Event® occurs when the price crosses a moving average. Three moving averages are supported: 21, 50 and 200 price bars. A price cross of a longer moving average indicates a longer term signal, in that the security may take a longer period of time to move in the anticipated direction.

A bullish signal is generated when the security's price rises above its moving average and a bearish signal is generated when the security's price falls below its moving average.

After a crossover is identified, it is considered "not yet confirmed". Then additional confirmation is sought by watching the slope of the moving average. A bullish event is "confirmed" if the moving average turns upward within 'X' price bars, where 'X' is the period of the moving average. For a bearish event, the moving average must turn downward as confirmation. In some cases, the moving average does not slope in the desired direction soon enough after the crossover, in which case the event is considered "never confirmed".

These events are based on simple moving averages. A simple moving average is one where equal weight is given to each price over the calculation period. For example, a 21-day simple moving average is calculated by taking the sum of the last 21 days of a stock's close price and then dividing by 21. Other types of moving averages, which are not supported here, are weighted averages and exponentially smoothed averages.


Trading Considerations

Moving averages are lagging indicators because they use historical information. Using them as indicators will not get you in at the bottom and out at the top but will get you in and out somewhere in between.

They work best in trending price patterns, where an uptrend or downtrend is firmly in place.

In trending markets, moving averages can provide a very simple and effective method of identifying trends.

Moving averages also act as support areas. You will often see a stock in an uptrend rise well above its 21 day moving average, return to it and then rise again.

Moving averages also act as resistance areas. When a stock trades under a moving average, that average will serve as a resistance price and it will be difficult for the stock to move above it. This is often very true when a stock has fallen below its 200 day moving average.


Criteria that Support

Indicators that are well suited to working with moving averages include the MACD and Momentum.


Criteria that Refute

Moving averages do well in trending markets but they generate many false signals in choppy, sideways markets.